2023-04-27 11:25:54 ET
Summary
- CHX reported strong 1Q23 results, with revenue in line with expectations and adjusted EBITDA and FCF exceeding market expectations.
- With the new margin guidance, I now see a way for historical margins to be achieved.
- With a decent dividend yield of 5%, I recommend a buy rating with a decent upside from its current share price if it meets my expectations.
Investment thesis
ChampionX Corporation (CHX) focuses on upstream & midstream oilfield technology such as chemistry programs and drilling activities. I am recommending a buy rating for CHX with the expectation of margin improvement, better cash flow conversion, and possible multiples re-rating. In addition, while waiting for thesis to play out, investors would enjoy a decent dividend yield of 5% through the holding period. Investors who have been keeping an eye on the company's potential for stronger margin realization will likely welcome the news that management has guided for a margin of more than 20% by exit 2023. Once CHX has shown that it can go past the 20% range, then, the path to realizing historical margins might come into the narrative, thereby further boosting the positive narrative around the stock as it improves margin sequentially. In light of management's comments, I think the company can improve its margins incrementally as it implements operational optimizations. I am positive on the long-term outlook and expect management to incrementally provide more concrete guidance brackets through the quarters, and also its long-term margin target.
1Q23 results
The $948 million in revenue that CHX reported was in line with expectations, and the $176 million in adjusted EBITDA it reported was about 4% above expectations of $169 million due primarily to higher margins than expected. The $69 million in FCF was well above market expectations, thanks to increased operating cash flow and reduced capital expenditures.
Margin
The most notable aspect here is management's forecast for EBITDA margin in FY23 to be higher than 20%. The impact, in my opinion, is substantial because it not only establishes the expectation for FY23 but also paves the way for CHX to achieve historical margin. MO do so, management has emphasized the importance of productivity improvement projects in order to boost the profitability of their operations. The stock price should have risen significantly in response to the improved forecasts and underlying initiatives. However, I can see why the market might be skeptical, though; boosting productivity often necessitates sweeping changes and constant tweaks from within the organization. Neither of these things is simple, and progress is usually slow in large organizations. However, I view this as a net positive because management is finally shifting the conversation to focus on what investors have been paying attention to all along: the potential for increased long-term EBITDA margins. I believe CHX stock has a lot of room to grow if the company can deliver on its promises and report financial results in line with expectations.
Cash flow
The FCF profile of CHX is also interesting to track. Compared to past periods, I find it interesting that CHX's free cash flow conversion in 1Q23 was around 40% of EBITDA. Management did note that the outperformance was the result of operational discipline and enhanced working capital management, both of which I anticipate will become the norm going forward. Consequently, I anticipate a corresponding improvement in cashflow conversion over time. Qualitatively, I'd like to emphasize that the reasons for this progress are not accidental, but rather the result of deliberate efforts to alter the way things are done in order to boost output efficiency. Also, I feel more optimistic knowing that management emphasized their ability to monitor daily metrics and drive continuous improvements throughout the company. Overall, I believe these developments will lead to more stable FCF generation going forward. In terms of guidance, management restated its target of a 50-60% FCF conversion (from EBITDA) for FY23 and its commitment to returning at least 60% of FCF to shareholders through dividends and share repurchases.
Valuation
Finally, the way for CHX to achieve historical margins is clear. The question is, what is the upside if it does? Based on consensus FY25 revenue estimates, CHX should generate around $1 billion EBITDA if it achieves a 23% EBTIDA margin in FY25 (assuming CHX takes 3 years to complete its project, a fairly reasonable timeline). CHX is currently trading at 7x forward EBITDA, which is 2.5x lower than its historical average. As a result, if CHX meets my expectations, there is a good 80% upside from here. Everyone, in my opinion, is sitting on the sidelines waiting for CHX to deliver as directed, which is why this risk/reward opportunity exists.
Author's model
Conclusion
CHX has reported impressive 1Q23 results, with revenue in line with expectations and adjusted EBITDA and FCF exceeding market expectations. Management's forecast of a margin of more than 20% by FY23 is a significant development, as it not only establishes expectations for the upcoming year but also paves the way for historical margins to be achieved. The company's focus on productivity improvement projects and operational optimizations is expected to boost the profitability of its operations and lead to more stable FCF generation going forward. With a decent dividend yield of 5%, CHX is a recommended buy, and if it meets expectations, there is a good 80% upside from its current share price. Overall, I am positive on the long-term outlook for CHX and expect to see incremental improvements in its financial results as management provides more concrete guidance through the quarters.
For further details see:
ChampionX Corporation: Improved Margin Guidance Is Great